We all know RBI allowed the structure default Guarantee/First Loss Default Guarantee on June 08, 2023 which had essentially prohibited by RBI through Guidelines on Digital lending (DL guidelines) Dated September 02 2022 consider economically equivalent to the synthetic securitisation as defined under the master direction– Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 ( “SSA Directions”).
However, the issued DLG guidelines create indecision in Fintech world and become difficult to frame a contractual arrangement with DLG provider.
So here, we came up with Few Frequently Asked Critical Questions (FAQs) and their answers to efface the doubts facing during contractual DLG arrangement.
Q.1 What would be the legal stance of Existing Contractual arrangements of default structured Guarantee?
Ans. The question of existing contractual arrangements of default structured Guarantee is not tenable here as RBI puts complete prohibition on Default structured Guarantee arrangement treating them as synthetic securitisation transaction by providing reference to the master direction– Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 ( “SSA Directions”).
However, if any contractual arrangement was in existence even after prohibition shall consider Void and illegal and not enforceable by the law.
Q.2 Is DLG Guidelines (“DL guidelines”) is applicable on Non-Digital Structured Guarantee/FLDG arrangement as well?
Ans. No, as it is clearly stated in the para 1 of scope and applicability that DLG Guidelines are applicable only on DLG arrangements contracted for “Digital lending” so applicability on DLG arrangements entered for Physical lending is not arise here.
Q.3 In furtherance to the above question the next question arise in the mind that weather Non-digital structured Guarantee arrangement are legal or not?
Ans. In our opinion the Non-digital structured Guarantee arrangement are not allowed as regulators consider these arrangements as synthetic lending under which risk and Spread are transferred to the DLG provider and entails them as status of synthetic lender however, Stakeholders are expected More clarity on this with the release of FAQ by RBI.
Q.4 Can DLG guidelines still applicable In case of Second loss guarantee or mezzanine guarantee?
Ans. Yes DLG guidelines covers all type of Pool level structured guarantee levels.
Q.5 Can DLG guidelines applicable on Full loss guarantee on entire portfolio or Loan-to-Loan Guarantee?
Ans. No, These DLG guidelines are only applicable on Default loss guarantee provided up to certain percentage of the loan Portfolio as clearly stated in para 2.1 of these guidelines therefore Default loss guarantee provided on entire portfolio is out of the ambit of this guidelines.
Q.6 Can an Individual or Partnership firm or LLP or Foreign company eligible to be a DLG Provider?
Ans. No, Only Companies incorporated under companies act 2013 or any other pervious company law are eligible to be a DLG provider as stated in para 3 of these guidelines.
Q.7 Whether LSP can made the Oral structured Guarantee arrangements as implicit guarantee shall also covered under the definition of DLG?
Ans. The first and foremost requirement of DLG arrangement is to execution of outsourcing agreement in line with Directions on Managing Risks and Code of Conduct in Outsourcing of Financial Services by NBFCs (“outsourcing guidelines”) which entails explicit legally enforceable contract between RE and DLG provider however, any arrangement which is not explicitly structured under contractual arrangement but gives a economic effect of guarantee linked with the performance of loan portfolio shall also consider under DLG guidelines.
However, here it is very important to understand here that the merely subsequent cash flows does not implies as implicit guarantee For e.g. Penalising DLG provider on the basis of his performance and Commission/Fee payments made on the basis of the performance of his service shall not consider as “implicit guarantee” Any formal understanding and arrangement agreed by DLG provider to make good the default of the loan portfolio which is not formally defined under contractual arrangement shall be treated as Implicit guarantee.
Q.8 Can DLG shall be provided in form of corporate guarantee nature?
Ans. No, As per para 5 of the DLG guidelines the DLG provider shall allowed to provide DLG only in form of cash or FD or BG marked in favour of RE.
Q.9 The limit of 5% of will counted on principal outstanding amount or on sanctioned amount or on disbursed amount.
Ans: The limit of 5% shall be counted on total value of disbursed amount and pre agreed and on fixed basis which will be active till longest tenor of the loan account of the guaranteed portfolio.
Q.10 What if Total outstanding amount of loan portfolio will become less than guaranteed amount?
Ans: The RE shall release the guarantee amount which is more than the outstanding amount.
Q.11 Would be criteria of using DLG amount as it is provided upfront to RE?
Ans. The contractual DLG arrangement requires DLG provider to deposit DLG amount upfront on the pre-defined basis in either any of 3 acceptable forms however DLG amount will be used by RE proportionally in the disbursed ratio.
Q.12 How long DLG remain in enforce?
Ans. The provided DLG amount shall remain in enforce till the longest tenor of the loan in the underlying loan portfolio.
Q.13 Can RE invoke DLG amount at SMA stage itself.
Ans. Yes, in pursuance to the para 9 of DLG guidelines the invocation of DLG amount can be done by RE on or before 120 days from the date of account become “overdue” which entail RE to invoke DLG amount at Special mention account stage it self.
Q.14 How to classify NPA accounts underlying in the guaranteed Assets portfolio in case DLG amount has been invoked?
Ans. The para 7 of DLG guidelines states clearly irrespective of the invocation of DLG amount the loan accounts shall be classified in accordance to the existing IRAC norms and invoked guarantee amount shall not be set off against the underlying individual loans.
However, any recovery made by the RE on later stage will be share with the DLG provider on the basis of terms set forth under contractual arrangement.
Q.15 What would be the impact on regulatory capital on loan guaranteed loan portfolio?
Ans. As RBI stated Capital computation, i.e., computation of exposure and application of Credit Risk Mitigation benefits on individual loan assets in the portfolio shall continue to be governed by the extant norms therefore the guaranteed amount would be treated as Guarantee assets and accordingly capital will be maintained on the net amount.
In addition to the enclosed questionnaire the DLG recipient make sure about the following things:
1. RE shall Put in place a Board approved Policy which shall include: Eligibility criteria for DLG provider, Nature and extent of DLG cover, Process of monitoring and reviewing the DLG arrangement, Details of the fees, if any, payable to the DLG provider.
2. Obtain Declaration from DLG Provider certified by SA certify following things:
3. Aggregate amount of DLG outstanding.
4. Existing DLG arrangements
5. Pas Defaults of same nature portfolio
6. Execute a legally enforceable contract In form of outsourcing agreement or DLG agreement which contain thing stated under para 4 of DLG Guidelines:
7. Extent of DLG cover
8. Form in which DLG cover is to be maintained with the RE
9. Timeline for DLG invocation
10. Disclosure of total no of DLG portfolio and their respective amount on the website of LSP.
Author Bio
Thank you sir!!
This is very informative